The expression "give until it hurts" can take on a new meaning when gift tax rules are concerned. Although you're free to give your money away any way you see fit, the IRS has rules for such generosity. But those are mostly for the purpose of preventing you from emptying your estate through gifts to avoid estate taxes.
Who Pays Gift Taxes
You pay gift taxes, as the individual making the gift. The beneficiary is usually exempt from having to worry about it. The IRS won't allow you to also claim the value of the gift as a deduction, unless you gave it to a charity. Donations made to individuals don't count as charitable contributions for income tax purposes. It also doesn't matter to the IRS whether you intended the gift as a birthday present or to help someone in need. Anything you give without receiving something in return is a gift and is eligible for federal gift tax.
Under the current rules, you can give away up to $13,000 to any one individual in a year's time without having to file a gift tax return along with your income tax return. This isn't $13,000 total in gifts, but applies per person. For example, you can give $13,000 to each of 10 people, for a total of $130,000.
In addition to the yearly exclusion of $13,000 per person, the IRS also gives you a lifetime exclusion of $5 million as of 2011. All gifts you make during your lifetime subtract from this exclusion. If you give away $130,000 in a single tax year, that means you have $4.87 million left to give away. But the exclusion also applies to your estate, so if you use up your $5 million by giving your assets away during your lifetime, you might have little left to shelter your estate from estate taxes when you pass away.
If you exceed the $13,000 limit per person the IRS offers a unified credit you can apply to the amount you gave her over $13,000, so you can escape paying taxes on it. This credit works similar to the lifetime exclusion in that it decreases each time you use it. As of 2011, the unified credit was $330,800. If you gave someone $20,000, you would owe a 35 percent tax on the balance over $13,000. This comes out to $2,450, or 35 percent of $7,000. The IRS allows you to use $2,450 of your unified credit so you don't have to pay a gift tax. However, you must subtract the $2,450 from $330,800. This leaves you with $328,350 to use in later years, either toward gift taxes or estate tax.
Exemptions and Other Tips
As with most IRS rules, there are some exemptions. For example these gift tax rules do not apply to gifts given to a spouse. Also, if you give money that is going toward medical care or tuition these gifts are exempt as well. Even if you eliminate gift taxes by using your unified credit, if you go over $13,000 to any one person for a non-exempt reason, you still have to file the gift tax return with your income tax return. Exclusions and tax rates change yearly, so if you're uncertain where you stand, speak with a tax professional.
- Comstock Images/Comstock/Getty Images